100+% APY with Bitcoin Liquidity Mining — How is That Possible?
For most readers 100% APY may sound a bit fishy and far from text book financial returns, but in the following article we’d like to explain how financial services are able to generate these yields. The magic word for this is liquidity mining.
Liquidity mining is simply one of many ways to put your crypto to work to generate even more crypto. In simple terms, it means that you deposit and lock up your crypto on a decentralized finance (DeFi) protocol and get the coin of the protocol’s native cryptocurrency as a reward.
Liquidity mining is also quite important for the DeFi protocols, because on the one hand it's a way to encourage investment and injection of liquidity and on the other hand it facilitates the decentralized trading between different cryptocurrency pairs (for example BTC-DFI). The provided liquidity is then pooled together and is cryptographically secured in a so-called “liquidity pools".
Liquidity pools are the backbone of decentralized exchanges (DEXs) and facilitate decentralized trading, lending or even more complex decentralized financial services such as minting synthetic assets. Users, so-called liquidity providers (LPs), have to add an equal value of two cryptocurrency coins in a pool to create a market. In exchange for providing liquidity, LPs earn trading fees from all trades that happen in the liquidity pool. The earned fees are directly proportional to their share of the total pool liquidity.
Besides receiving trading fees, liquidity providers also receive cryptocurrency rewards from the respective protocols. These cryptocurrency coins (coins of the respective liquidity mining protocol) are distributed proportionally and in the same way as the trading fees by calculating the liquidity provider’s share of the total liquidity. This has also been one of the best approaches to further decentralize new DeFi projects and to get the native cryptocurrency coin fairly distributed.
In essence, each liquidity provider’s total return on his invested funds can be calculated with the formula: Total ROI = Trading Fees + Cryptocurrency Rewards. The trading fee structure and the emission of the cryptocurrency rewards (how many coins a project provides for a certain liquidity pool) is set by the owners of each liquidity pool. Let’s have a quick look at how DeFiChain, a DeFi project built on top of Bitcoin, is doing it.
DeFiChain’s biggest liquidity pool is the BTC-DFI pool, where you have to provide equal value of Bitcoin and DeFiChain’s native cryptocurrency token ‘DFI’. DeFiChain is currently incentivizing its Bitcoin pool by 135 DFI every 37 seconds. Besides that liquidity providers are also receiving a fraction of the trading fees generated in that pool.
Assuming this Bitcoin pool only has 10,000 USD of total liquidity and your initial investment is 1,000 USD (= 10% pool share), then you’ll get 10% of 135 DFI (= 13.5 DFI) every 37 seconds as well as 10% of the transaction fees generated during this period. Now let’s assume the pool has 1,000,000 USD total liquidity and once again you’ve invested 1,000 USD — then your share of the total pool is just 0.1%. This means that you’ll now get 0.1% of 135 DFI (= 0.135 DFI) every 37 seconds. At a current price of more than US$3.50 per DFI, this accumulates quickly to a sizable amount.
As you can see, there really is no magic going on behind the curtain other than simple maths. That’s also the reason why liquidity pools often provide APY values in excess of 100% or even 400%, especially for newly created liquidity pools that are still lacking liquidity providers. Table 1 gives a quick overview about liquidity mining and its advantages and disadvantages.
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Let Cake DeFi do all the work for you while you sit back and relax and see money hitting your account. You can open an account with just a few clicks and start earning right away with liquidity mining.
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